Muni Market Still Unfazed By Puerto Rico Junk Downgrades

By Michael Aneiro

Ten days have passed since Fitch became the third big rating agency to downgrade Puerto Rico to junk this month, and yet the muni market is still showing no real ill effects. There were concerns that a downgrade could trigger forced selling by funds with investment-grade mandates, and there are still some worries that there could yet be some selling by the end of the month, but so far so good. Here are Morgan Stanley Wealth Management muni strategists John Dillon and Matthew Gastall:

Whether it be the shortened week, severe weather, or even a “wait and see” mentality regarding Puerto Rico’s upcoming general obligation bond sale, the broader municipal market has yet to exhibit a notable reaction to the Commonwealth’s triple downgrade by S&P, Moody’s and Fitch.

Dillon and Gastall say the lack of broader reaction shows that muni investors are starting to differentiate between idiosyncratic, one-off risk like Detroit and Puerto Rico and the overall health of the broader muni market.

Even Puerto Rico’s bonds haven’t felt any ill effects from the downgrade (partly because the market largely already regarded them as junk before the rating agencies made it official). S&P Dow Jones Indices reported today that yields on the S&P Municipal Bond Puerto Rico General Obligation Index have come down by 70bps since February 11 to 7.53%, helping to drive a year-to-date return of over 10% for Puerto Rico bonds. The broader S&P Municipal Bond Puerto Rico Index, including revenue bonds as well as general obligation bonds, has returned 4.94% year-to-date.

S&P DJI says the migration of the recently downgraded Puerto Rico bonds into the high yield index is helping those returns as well, as high yield bonds tracked in the S&P Municipal Bond High Yield Index have returned 3.96% year-to-date.